David Prosser: EU's good intentions to hit savers

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Outlook Most people won't have a clue what insurance companies mean when they talk about "enhanced annuities", but the strategic decision announced yesterday by the French insurer Axa to stop selling these products in the UK should worry millions of pension savers.

One of the main reasons that Axa is pulling out of this niche market – where people with serious health conditions are able to buy higher pension incomes with their savings because they have shorter life expectancies – is its mounting concern about new European Union rules on capital adequacy.

One effect of this regime, also known as Solvency 2, is to force insurers to set aside considerably more capital against their annuity liabilities. Axa has decided that the demand for its enhanced annuity range is not sufficient to justify the additional capital provisions doing new business will force it to make.

Like other insurers, Axa is staying in the conventional annuity business. But the bad news is that the incomes on offer are likely to fall across the board because of Solvency 2. The higher the pension an insurer offers, the more capital it will have to set aside, so annuity rates are set to fall.

For anyone in a defined contribution pension scheme – either a personal arrangement with a private sector provider or an occupational plan where the employer does not guarantee a set level of retirement income – that's bad news. It means their pension savings will, on retirement, buy less annual pension income than it would have done prior to the introduction of Solvency 2.

Or, to put that another way, the latest rules from the European Union, introduced with, ultimately, the security of savers in mind, will actually result in many people being less well-off in old age.

It's not all bad news – for now, at least. Bond yields, to which annuity rates are linked, have been on the rise in recent months, which should mitigate the worst effects of Solvency 2. Moreover, the annuity market has become more competitive in recent years – those savers prepared to hawk their pension funds around different insurers as they get nearer to retirement ought, therefore, to get more for their money.

Unhappily, however, most savers still don't exercise their right to take the "open market option" when cashing in their pension funds. So if they happen to be with an insurer that doesn't choose to compete in the annuity market, they will end up with a much lower pension income than others with the same cash to spend.

Bear in mind too, that insurers are still trying to get to grips with the Solvency 2 rules and have only just begun to explore what they mean for the pensions industry. There may be further stings in the tail to come.

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